The Debt Ceiling 101

October 16, 2013

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It’s been all over the news lately. The debt ceiling. CNN even has a countdown clock till we hit it, like some dramatic movie, ticking down the time till the asteroid hits the economy. The debt ceiling. Something hovering over us all like some sort of magical barrier desperately saving us from ourselves. But what is it exactly and why have our politicians lost their collective minds over it? Why are the markets so nervous about it, and why is the world watching with baited breath to see if the US actually hits it? Find out below.

Debt Ceiling CountdownDefining the Debt Ceiling

Let’s keep this simple. About a hundred years ago, the country set a legislative limit on the amount of debt it could incur. It describes the maximum amount of money the US can legally borrow. In a nutshell, it’s like your parents saying, “You can only borrow this much, and you can’t go over it. If you do, we’re cutting you off.”  That’s it. You go over it anyway (of course), but instead of your parents cutting you off like they said they would, they consider raising your limit. They just need to work out the details.

Currently, the US limit is $16.7 trillion (that’s trillion with a capital “T”), which is probably slightly higher than what your parents loan you. This is about $25 billion shy of the precise legal limit. This Thursday, October 17th, the US is expected to hit this limit, which means that unless Congress (our parents) raise the debt ceiling (how much we can borrow), the US will go into default, meaning Treasury can’t pay its debt obligations.

The Department of the Treasury

This is really, really bad. As in historically bad. In its entire history, the United States has never defaulted. Ever.

Well…Who Does the US Owe?

For the most part, its own citizens. Sixty-six percent of the country’s debt is held domestically.  It’s primarily US individuals and financial institutions, with the key groups being the Social Security Administration (FUN FACT: the entire Social Security trust fund — over $2 trillion — is invested in Treasury bonds, which is required by law), pension plans and retirement accounts. If you have a retirement plan as a recent grad then you are WAY AHEAD OF THE CURVE. But it also means you are probably lending money to the US government, which puts you right back into the curve. Sorry.

Another key creditor is the Chinese government. It holds about $1.2 trillion in Treasury bonds. Not surprisingly, China would very much like to see the US avoid a default.

So, What Does Default Mean to Me?

We The PeopleChris Weafer, a senior partner at Macro-Advisory.com, puts it this way: “[The world’s financial system] would start to freeze up. Banks would pull back from risk and lending. The US economy would slide towards recession and the global economy would quickly be affected.” He also adds that a “prolonged US default would lead to job losses everywhere and much tougher borrowing conditions for companies and individuals.”  This is exactly how it could impact you: job loss and increased difficulty in finding one, and also the inability to get a personal loan, from your bank or your parents.

But all is not bad. As of this writing, the White House and congressional leaders were very close to a deal, with Senate Majority Leader Harry Reid saying that tremendous progress has been made. You might also want to take that with a tremendous grain of salt, but at least the two sides are talking to each other and working to come to a solution. In the meantime, all you can do is keep an eye on the headlines, be prepared, and most importantly, keep practicing your ABNs. You never know when it might come in handy, especially in today’s climate. A debt ceiling is not necessarily your ceiling.

 

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